Corporate Tax Rate’s ‘Silly’ Effect on Decisions to Build Factories

Just when you thought it couldn’t get worse it did. No jobs were created in the U.S. economy last month. Zero. Nada. Zilch.

That must leave the White House feeling like a bunch of zeros, too. They must be thinking: How is it that U.S. corporations are raking in huge profits and sitting on piles of cash, but still won’t hire?

If it seems silly that corporations behave this way, it’s because, in part, the way they decide to invest in new job-bringing factories is silly.

Reuters

Decisions to open new factories are influenced by the corporate tax rate, not necessarily rates the company will pay.

But the president could help fix that silliness when he unveils his jobs plan next week. It’s all to do with corporate taxes.

When corporate analysts assess whether to build new factories they look at after-tax profits. To do that they make assumptions about corporate tax-rates. There’s the rub, because, get this, they don’t use the actual tax rate the company is paying — close to zero in many cases. No, the analysts use the corporate tax rate of 35%.

What’s really silly is that this analytical method is considered “best practices” in corporate America. I know, I used to do this type of work.

That tax rate makes a huge difference. It can turn a marginal project into an appealing one and vice versa. It doesn’t matter that the corporation maybe paid zero tax last year and likely won’t any time soon either. The analyst still has to use the higher tax rate. (The reasons for this are technical — but broadly the idea is that every extra dollar of profit could theoretically be taxed at that marginal rate as the company adds taxable profits. Theoretically true, but often nonsense in practice.)

Still, the bosses won’t let him or her use anything different than the headline rate (now 35%), until the government changes the corporate tax rate.

The question the White House should be asking this weekend is this: Which is easier: change the ingrained way corporations make their decisions; or change the tax-rate on profits that result from new investment?

Of course, that won’t change the dismal economic outlook, which itself has a huge bearing on investment decisions.

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